I write primarily about the U.S. public and private retirement system. Trained in economics (1999 PhD from MIT), I serve as the William Karnes Professor of Finance and Director of the Center for Business and Public Policy at the University of Illinois. I am also Associate Director of the Retirement Research Center at the National Bureau of Economic Research (NBER). Previously, I served as Senior Economist with the President’s Council of Economic Advisers, as staff to the President’s Commission to Strengthen Social Security, and as a Member of the Social Security Advisory Board. I am also a Trustee for TIAA-CREF, a Fortune 100 financial services firm serving the not-for-profit sector.

Illinois Public Pension Reform: A Simple but Radical Idea

After a week of legislative wrangling that had more twists and turns than Hawaii’s famous “Road to Hana,” the Illinois General Assembly failed to come to agreement last week on a pension reform package in time for yesterday’s May 31 deadline. As a result, they will return to Springfield – possibly this week – for a special session facing an even larger hurdle for passing reform legislation: by Illinois law, bills passed after May 31 require a three-fifths vote rather than a simple majority.

Agreement fell apart over the issue of who should pay for the “normal cost” of future public pension accruals. “Downstate” lawmakers objected to shifting all of the costs onto school districts, public universities and community colleges on the grounds that this would lead to higher property taxes to fund teacher pensions and do grave damage to the ability of our university system to compete for academic talent. Once Democratic Governor Quinn agreed to pull this cost-shifting out of the bill, Democratic House Speaker Mike Madigan withdrew his support of the bill.

As I wrote this past Wednesday, one of the grave concerns I have about the leading proposals is that so many of our elected officials seem perfectly content to shift all of the costs onto universities and school districts while maintaining legislative control over the design of the benefits package. This is a mistake on so many levels. The separation of responsibility and control is a recipe for fiscal shenanigans. It is also highly disrespectful of the employer-employee relationship that Bob Rich and I wrote about in our pension reform proposal earlier this year.

Although I still like the plan that Bob Rich and I put out, it seems clear that the General Assembly has gone another route. But given that they are stuck on the cost-shifting issue, I thought it might be useful to put forth a more radical proposal that would respect the constitutional constraints, appropriately align the incentives of all the affected parties, respect the employer/employee relationship, and still save the state billions. Perhaps most importantly from a political perspective, it might overcome the cost-shifting stalemate, because it shifts the costs but offers something very valuable in return. This proposal would apply to those institutions – such as school districts, universities and community colleges – that, while public, are not part of the state government apparatus itself.

While “radical,” the idea is deceptively simple. Here it is in 4 simple steps:

1. The state agrees to pay 100% of all pension benefits that have been accrued by public sector retirees and current workers as of 7/1/2013. Whether the state wishes to do this by paying down the amortized unfunded liability, or simply provide the cash as need to pay benefits, is immaterial, so long as they respect the constitutional guarantee and pay it. Not only does this respect the constitution, but it would also be fair to the generations of workers and retirees who consistently paid their share to the pension fund while the politicians enjoyed their “pension funding holidays.”

2. The existing public pension plans – for example, TRS and SURS – are closed to all further accruals as of 7/1/2013. No new benefits will be earned under any of the plans.

3. Going forward, each state employer is given 100% autonomy – free from the shackles of state regulation and political interference – to construct a benefits package that is optimally designed for its own employees. In order to comply with federal law that applies when a state like Illinois opts out of Social Security, each employer would be required to provide a retirement package that is at least as generous as Social Security. Beyond that, it would be up to each employer to determine the optimal mix of wages, pensions, and other employee benefits that would be required to attract, retain, motivate, and manage the retirement of their workers. If similar employers wished to joint together as a group (e.g., all community colleges) to provide a common pension plan, or if unions wanted to provide multi-employer pensions funded by a group of employers, they would be permitted to do this. But if the University of Illinois decided that its needs differed sufficiently from other public universities, they would have the freedom to go their own way.

4. The state would agree to a pre-determined, annual “block grant” (basically, an extra appropriation) to each employer that would start out as an amount equal to the “normal cost” of providing pensions, and would gradually decline to zero over a 20-year period of time. This would slowly shift the entire financial burden of providing pensions from the state to the employers themselves.

In essence, this plan calls for 100% cost-shifting, but with two critical differences relative to the reform package being debated last week. First, and most importantly, it accompanies the cost-shifting with a freedom from political interference. Second, it spreads the cost-shifting out over a much longer period of time (twenty years instead of approximately eight or so) in order to ensure that employers can adapt.

If there is anything I have learned from observing our Illinois state government in action, it is that it cannot relied upon to design a sensible pension package that is fiscally sustainable, credible to employees, and meets the diverse needs of our public employers. So if they are so eager to get out paying for pensions, let’s take this idea all the way – aside from atoning for their past sins by making good on constitutionally guaranteed promises that they have so far failed to fund – let’s have the state get out of the pension business altogether.

Doing so would free employers and employees from being subject to the unpredictable whims of the states’ politicians. And that freedom, it seems to me, is priceless.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

There’s an even simpler solution. Join social security and let each employer supplement that as it sees fit. Opting out of social security, as Illinois has done, invites moral hazard because so many people find ways to “double dip”.

The idea of joining Social Security is more complex than it first appears. Keep in mind that Social Security is itself almost entirely unfunded – it works by taxing today’s workers to pay today’s retirees. As a result of this design – combined with demographic changes (lower birth rates, longer lives, etc) – Social Security is itself not fiscally sustainable. Indeed, for current generations, the “internal rate of return” to Social Security can be quite low. It is not at all obvious that Illinois public workers would be better off in such a system. Although including them has other benefits …

I’m a State of Illinois employee. I’m not sure what “closed to all further accruals” means. If you mean that we would not contribute to SURS after 7/1/13, but rather the self managed plan or the 457 and similarly, we wouldn’t be able to buy time, then that’s a good idea. Everybody realizes that the system isn’t solvent.

Yes, closed to all further accruals means that you would no longer contribute to SURS and would no longer earn additional benefits from SURS (beyond what you have already earned). Starting 7/1/13, your employer would provide a new plan that would presumably be funded by a combination of contributions from you and the employer. Whether this was a defined benefit plan, a defined contribution plan, or a hybrid plan would be up to the employer to choose with input from their employees.

BTW, your idea would seem to solve the problem of shifting the cost away from the state of Illinois to the agency hiring the employee. After 7/1/13, the agency would (or would not) match the employee contributions according to what they can afford. The state would no longer need to contribute anything. The state would be more of the plan administrator for health benefits and could manage the money of those that chose to trust them with it. The money budgeted for matching funds would be used to pay down the debt and make the system solvent.

Thanks Older … yes. They key is aligning responsibility and control. But obviously we cannot just do this overnight or it imposes a huge financing burden on employers. Thus my idea of doing it in small bits over, say, two decades.

Thomas, Sorry for the delay in responding. What I had in mind in your case would be the following. If you have earned 55% of final average salary, then what I have in mind is letting you have 55% of your final average salary – where we still define your final average the way we always have. But instead of adding to this 55% over the next 6 years, you would instead spend the next 6 years contributing to and earning benefits from a new system set up by your employer. Jeff

I would like to share with you and your readers a letter I sent Governor Quinn last week. I believe it expresses the attitudes and feelings of teachers (at least the ones I talk to), a group who seems to be bearing the brunt of consequence for all the fiscal mismanagement that has occurred over decades.

Dear Governor Quinn,

My name is Kirk Mango, I am a 33 year veteran at Downers Grove South High School entering my last year (34) in teaching. I have heard and read so many things, from both sides, regarding our state’s fiscal issues and the current pension dilemma.

I wanted you, and all concerned, to know that teachers are very sympathetic to the financial situation the state is currently in. We know that our current pension is very good, and all are exceptionally appreciative of that fact. Actually, it is this exact pension system that kept many teachers plugging away, doing the best that they can, to make a difference for kids. And this is even when considering the low salaries, much lower than the private sector, back when I started teaching 33 years ago. We may not have started teaching because of the pension, but many certainly stayed in the system because of it. I know I did.

We also know that this situation has been caused by decades of fiscal mismanagement by government officials from the past, your predecessors. We know that neither you, nor the taxpayers, nor teachers (and we are taxpayers too) are at fault, and that you are held with the bag, the responsibility, to fix this mess. And we know that something will have to be done. You cannot squeeze water out of a rock, and that analogy does loom large in the future based on forthcoming pension liabilities the state has. It is hurting all of us, both private and public.

If I might suggest, it would be much easier to get acceptance from teachers, and their union, if they were not the only ones that are feeling the brunt and major consequence of all the proposals that have been suggested. It seems to us, and I have conversation and contact with many, that we are being punished for something we did not cause, and we have paid faithfully into the system for our entire careers. A payment consisting of 9.4% of my salary, plus another 1% (approximately) for our TRS insurance benefit, totaling 10.4 % of our gross salaries going into the system from every paycheck, and every teacher in the state.

For example, many of my colleagues would favor: Increasing the percentage we put into the system (and that would be a hardship for some), a change to COLA that is more in line with CPI each year (purpose being to maintain living standards on into retirement), and a slight increase to what each district pays into the system based on the employees that work in that district each year; all of these in lieu of more drastic changes to the current benefits. We are willing to pay more, and do more. However, this must include a way to increase funding to the system that not only pays back the decades of money owed but also supports the system on into the future. And this needs to be something that is legally binding, paid first like someone pays their mortgage, and NO IOU’s ANYMORE.

Again, the mistake our government officials are making is to place all consequence on teachers, and other public employees, even though it is ALL of us (private and public sectors) who voted in the individuals in the past who were so fiscally irresponsible over decades. I believe working together with the aforementioned philosophical basis would be very advantageous to finding a better solution.

Lastly, and most importantly, I think it would behoove all, including our current state representatives, to allow a forensic audit of all the state’s finances so that real, true cuts can be made where they are needed. Things like being able to work for a minimal amount of years, not the 35 years teachers (and others) must put in before full pension benefits and still receive a full pension, special monies (or favors that cost money) paid to groups and organizations, monies going to unnecessary, outdated, ineffective programs, etc. should all be dropped from the budget where needed. Actions like this would bolster support for any changes you and other officials might want to make as our state’s finances would then become transparent. There is more money to distribute fairly if one looks close enough.

If we want to make a difference, we are going to have to travel a path not yet traveled. It is in the best interest for all concerned. I fear if we continue to travel the current direction, it will cause hardship for everyone concerned, not just teachers and other public employees. In addition, if we want to continue to attract passionate and high quality individuals to educate our youth, we cannot, in good conscience, accept the current proposals on the table.